Unleashing repressed inflation feeds inertial inflation and delays recovery
Macri’s government inherited an economy with large macroeconomic disequilibria and extreme relative price misalignments. The disequilibria and misalignments created by capital and price controls and inefficient regulations distorted the functioning of most markets for goods and services.
The new government has stated it seeks to organize the economy as an open market economy with sound fiscal and monetary policies as a way to gradually reduce inflation in four years.
So far, the new government has removed exchange controls, eliminated most export taxes and quantitative restrictions on exports and is seeking to unfreeze (read “raise”) public utilities prices to reduce economic subsidies to public utilities companies.
In spite of a tight monetary policy, the initial impact on inflation of these adjustments has been significantly higher than predicted both by the government and by most economic analysts. The acceleration of inflation and the drastic reduction in public capital expenditures at the national and provincial level generated a recession that was particularly severe during the second quarter.
Inflation, measured by the CPI, accumulated close to 27% during the first half of the year and climbed to 45% on annual basis, according to private estimates.
In addition to the stagflationary costs of the macroeconomic and relative price adjustments, the government is still trying to overcome legal constraints imposed by some judges on the increases in public utilities prices. The stop-and-go process in fee adjustments has skyrocketed the political costs of the initiative and increased concerns about the dynamics of the fiscal accounts, particularly during the electoral cycle of 2017.
On the positive side, the risk premium on government debt is declining rapidly, and external credit conditions for both the government and the private sector will probably continue to improve after the recent tax amnesty sanctioned by Congress. This is a necessary (though not sufficient) condition to spur private investment, the cornerstone of the official economic strategy.
On the other hand, domestic credit in pesos continues to be quite expensive for both the private and the public sectors, as a consequence of the restrictive monetary policy that is trying to keep interest rates high in real terms.
There are indicators that suggest that inflation will decline during the second half of the year but, even in that case, annual inflation will be close to 40% in 2016.
If the government continues with the current gradualist strategy to conduct the required adjustments and does not tackle inertial inflation rapidly with a full-fledged stabilization plan to drastically reduce inflationary expectations, the inflation rate may remain around 27% in 2017. However, it should not be completely dismissed that – given the poor results of 2016 – President Macri will finally decide to introduce a full-fledged stabilization plan. If he implements such a plan at the beginning of next year, a reduction of the inflation rate to around 13% in 2017 is feasible.
In line with this view, we have revised our forecast for 2016 and hereby present two scenarios for 2017. The first one is similar to the consensus view of local pundits. The other shows what could be the outcome of a full-fledged stabilization plan if President Macri changes his strategy towards the end of 2016 and targets a 12-13% annual inflation for 2017.
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